As the S&P 500 closes out an extraordinary 2024 with a 26% year-to-date gain, all eyes turn to the incoming Trump administration and its potential influence on the stock market. Investors have reasons to be optimistic and cautious as the benchmark index prepares to enter a new chapter in 2025.

Strong Performance During Trump’s First Term

During Donald Trump’s first presidency (2017-2021), the S&P 500 surged by 70% — an annualized return of 14.1%, making it one of the most successful stock market periods for any U.S. president. Much of this success was attributed to:

  • Tax Cuts: The 2017 Tax Cuts and Jobs Act significantly lowered corporate tax rates, boosting business profits and consumer spending.
  • Economic Growth: U.S. GDP growth averaged 2.7% annually from 2017 to 2019, outpacing the 1.5% average of the previous decade.

This strong market performance under Trump was second only to Bill Clinton’s presidency, which saw annualized returns of 15.2%.

A More Expensive Market in 2025

Unlike 2017, Trump’s second term will begin with the S&P 500 at a much higher valuation. As of December 2024, the index’s forward price-to-earnings (P/E) ratio sits at 22.2, a level not seen since April 2021. Historically, such elevated valuations have preceded periods of low returns or steep corrections.

  • Historical Context: Previous periods when the S&P 500 traded above a 22 P/E ratio — such as the dot-com bubble and early COVID-19 pandemic — ended with significant pullbacks of 25%-50%.
  • Implications: Apollo Global Management’s Chief Economist Torsten Slok estimates that a forward P/E multiple of this level implies annualized returns of just 3% over the next three years.

Balancing Optimism with Caution

While Trump’s first term was marked by tax cuts and deregulation, which fueled corporate growth, investors should temper expectations this time around. The S&P 500’s higher valuation could make further gains more challenging, and corrections or bear markets remain a real possibility.

How Investors Can Prepare

  1. Temper Expectations: Investors should be realistic about the potential for lower returns given the market’s high valuation.
  2. Monitor Valuations: Pay close attention to forward P/E ratios and other valuation metrics when making investment decisions.
  3. Build Cash Reserves: Maintaining a larger-than-normal cash position can allow investors to capitalize on buying opportunities during future corrections or bear markets.

Donald Trump’s second term comes with high market valuations and potential for policy-driven growth. However, the elevated P/E ratio suggests that investors should brace for lower returns than during his first term. By remaining cautious, monitoring valuations, and preparing for potential market pullbacks, investors can position themselves to weather turbulence and take advantage of long-term opportunities.